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Liz Kirby
Elisabeth Kirby
Managing Director and Head of Market Structure, Tradeweb

This article originally appeared on here.

Update: After this article was published, the FCA issued a statement confirming the end dates for the various LIBOR settings and the New York Fed and ARRC issued an accompanying statement supporting these developments. The announcement clarified the timeline for when swaps must move away from referencing LIBOR, to the new benchmarks.

As LIBOR is phased out, new options will be necessary. Choosing the right one will take some research.

Investment professionals are carefully watching what will happen to the U.S. London Interbank Overnight Rate (LIBOR). LIBOR, which is a globally accepted, dominant key benchmark interest rate used to set borrowing costs between financial institutions, has faced some criticism in the past, especially around price manipulations. However, with an estimated $350 trillion in outstanding loans and trading contracts hinging on this calculation, it’s no surprise that long-term changes and the looming elimination of the rate is making many in the industry nervous. The fact that its phase-out date is not set in stone – the Federal Reserve on November 30, 2020 announced the phase-out would be extended to June 2023 -- adds even more confusion into the mix.

“It’s a little bit unclear, because the Fed has still indicated that they expect the market to make the change in 2021, and any usage after 2021 should be limited to certain situations such as reducing existing LIBOR exposures,” explains Liz Kirby, Head of Market Structure at financial services and electronic trading company Tradeweb. “However, there remains some ambiguity in the marketplace at this point around how that nuance is going to play out or be enforced.”

Kirby says the industry saw the market move off the back of that news, both in the swaps side and the futures side, and, as a result, some institutions are already transitioning to alternative reference rates. For instance in the U.S. mortgage market, government-sponsored entities including Fannie Mae and Freddie Mac began transition away from LIBOR-based adjustable-rate mortgages and mortgage-backed securities to the Secured Overnight Financing Rate (SOFR), which is “a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities”, according to the Federal Reserve Bank of New York.

SOFR, according to the Fed, “includes all trades in the Broad General Collateral Rate plus bilateral Treasury repurchase agreement (repo) transactions cleared through the Delivery-versus-Payment (DVP) service offered by the Fixed Income Clearing Corporation (FICC), which is filtered to remove a portion of transactions considered specials.” SOFR is a welcome addition, but investors may still need additional offerings. SOFR is an overnight rate; there are currently no longer terms being published. In addition, there has been some concern regarding several notable spikes in the rate since it is based on the Treasury repurchase marketing. These elements can create additional overhead in determining a loan rate.

Finding a Different Path
With the transition looming, market participants may want to consider alternative rates that are most appropriate to them. The good news for financial services companies is that there are several other options available today. These include the Bank of England’s Sterling Overnight Index Average (SONIA), the Swiss Average Rate Overnight (SARON), the Tokyo Overnight Average Rate (TONA) and the newly introduced European Central Bank Euro Short-Term Rate (€STR). Another important addition comes from Tradeweb and ICE Benchmark Administration. The organizations have teamed up and created the constant maturity treasury (CMT) rate as an alternative and a complement to both LIBOR and SOFR. Tradeweb and IBA conducted an eighteen-month study to test their CMT rates, and the results were solid. Testing showed consistency with the Daily Yield Curve Rates produced and published by the U.S. Treasury, according to the July 2020 report the organizations released. Another finding: Using back-testing of the curve fitting and rate production methodology, Tradeweb’s ICE CMT rates had a close daily correlation with the Daily Treasury Yield Curve Rates produced by the United States Treasury.

The Tradeweb CMT offering can help investment and financial professionals get through the LIBOR transition by providing an alternative option that’s both stable and based on deep and extensive transactional data, Kirby says. The Tradeweb ICE CMT rates track the volume-weighted average price of US Treasury bills, notes, and bonds using trades executed on the company’s dealer-to-client platform. It was created with feedback from existing clients and takes into account their needs for an alternative to LIBOR.

In addition, CMT offers rates for maturities of one, two, three, and six-month terms, and one, two, three, five, seven, ten, 20, and 30 year terms, all of which mimic the maturities of the most frequently issued U.S. Treasury securities. The inputs used to generate the Tradeweb ICE CMT Rates will be based upon volume-weighted average prices, and associated yields, derived from transactions or quotes on the Tradeweb institutional global platform, over the course of a 7-hour window between 8:00 a.m. and 3:00 p.m. Eastern, according to the companies. Since Tradeweb is able to compute its rate based on actual trade executions as well as live executable prices, it should lead to more accurate rates than benchmark rates that use more indicative market data, for example. There is a wide audience for CMT, Kirby says.

“This could be useful for mortgage originators who could create adjustable-rate mortgages linked to the Tradeweb ICE CMT Rate. Our CMT rate could also be beneficial to market participants who need a benchmark for short-duration funds or for cash products, like floating rates and loans,” she says. “The transition away from LIBOR will be complex, and market participants should consider rates that work for them.” Another option: Tradeweb is also working with benchmark administrators who are producing beta Term SOFR rates as a data provider.

CMT could fill a need created by a lack of market consensus and critical mass of participants moving over to SOFR. In addition, it helps some markets such as the mortgage market, that weren’t widely using LIBOR to begin with since SOFR may not meet their needs as fully as a rate based upon Treasury yields would.

Adds Kirby: “We’re not looking to compete with or displace these other reference rates. It’s a complement to the existing solutions in the market. Tradeweb is committed to making the transition seamless and supporting all benchmark alternatives throughout the process through the use of advanced technology and optimized trading functionalities. However we do think that we are in a position to offer a more robust and more accurate rate than some of the other options that are out there because of the volumes transacted on our platform every day.”